Timely Loss Recognition and the Early Termination of Unprofitable Projects*

39 Pages Posted: 2 Sep 2009 Last revised: 22 Apr 2011

Anup Srivastava

Tuck School of Business at Dartmouth

Senyo Y. Tse

Texas A&M University - Lowry Mays College & Graduate School of Business

Shyam V. Sunder

University of Arizona - Department of Accounting

Date Written: April 18, 2010

Abstract

Ideally, firms should discontinue projects that become unprofitable. Managers, however, continue to operate such projects because of their limited employment horizons and empire-building motivations (Jensen 1986, Ball 2001). Prior studies suggest that timely loss recognition in accounting earnings enables lenders, shareholders, and boards of directors in identifying unprofitable projects; thereby, enabling them to force managers to discontinue such projects before large value erosion occurs. However, this conjecture has not been tested empirically. Consistent with this notion, we find that timely loss recognition increases the likelihood of timely closures of unprofitable projects. Moreover, managers, by announcing late discontinuations of such projects, reveal their inability to select good projects and/or to contain losses, when projects turn unprofitable. Accordingly, thereafter, the fund providers and board of directors are likely to demand improved timeliness of loss recognition and stringent scrutiny of firms’ capital expenditure plans. Consistently, we find that firms that announce large discontinuation losses reduce capital expenditures and improve timeliness of loss recognition in subsequent years. Our study provides evidence that timely loss reporting affects “real” economic decisions and creates economic benefits.

Keywords: Timely loss recognition, Conditional conservatism, Agency costs, Corporate governance, Project discontinuations, Accounting quality

JEL Classification: G14, G34, M41

Suggested Citation

Srivastava, Anup and Tse, Senyo Y. and Sunder, Shyam V., Timely Loss Recognition and the Early Termination of Unprofitable Projects* (April 18, 2010). Available at SSRN: https://ssrn.com/abstract=1465980 or http://dx.doi.org/10.2139/ssrn.1465980

Anup Srivastava (Contact Author)

Tuck School of Business at Dartmouth ( email )

Hanover, NH 03755
United States

Senyo Y. Tse

Texas A&M University - Lowry Mays College & Graduate School of Business ( email )

Wehner 401Q, MS 4353
456C
College Station, TX 77843-4218
United States
979-845-3784 (Phone)

Shyam Vallabhajosyula Sunder

University of Arizona - Department of Accounting ( email )

301V McClelland Hall
1130 E Helen St
Tucson, AZ 85721
United States

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